The CIG Power Corporation expects to report earnings before interest and taxes of $25 million this year. Management has determined that the firm needs $10 million of new capital this year to fund its anticipated capital investments. One alternative is to borrow the funds from a syndicate of banks at a 15 percent rate of interest. Alternatively, CIG could sell $10 million of a new preferred stock that pays annual dividends of $1.4 million. The marginal tax rate for CIG is 40 percent.
a. What will be the “earnings after tax and available for common stockholders” if the money is borrowed?
b. What will be the “earnings after tax and available for common stockholders” if preferred stock is sold?